Annuities have become a more attractive option for retirement savings. Once considered noncompetitive and inflexible, annuities have become more popular as annuity providers have introduced products with a variety of flexible tax-deferred savings options. An annuity is a tax-deferred savings vehicle packaged as an insurance product. In most cases when an annuity is bought, its earnings are tax-deferred until the beginning of withdrawal of the interest or other income earned. Often an annuity includes a mandatory waiting period between the purchase of the annuity contract and the first withdrawal period. Because the owner is not paying taxes on gains made during the waiting period, the owner has the chance to earn gains on untaxed money, which may grow more quickly than a taxable account does. Indeed, earnings have the potential to compound more quickly and when the owner reaches retirement age, their tax bracket in retirement is often lower than it is in the income-earning years.
Annuities were classified as either fixed or variable. A fixed annuity provided a set minimum guaranteed rate of return backed by an insurance company, much as a bank provides a stated rate of return on a certificate of deposit. Although the rate of return varied somewhat depending on the prevailing interest rates, the minimum rate of return provided more stability than a variable annuity. Funds in a variable annuity were to be invested in stocks, bonds, or money market funds, depending upon the type of subaccount chosen. Usually, the subaccount was selected based on the level of risk and return wanted in the annuity, just as when purchasing a mutual fund. The amount of return depended on the actual return of the subaccount investment and there was not minimum guaranteed rate of return associated with a variable annuity.